Summary
- Citi beat on a pre-provision basis, but the beat was driven by stronger trading and investment banking performance, as core banking modestly underperformed.
- Citi management made another large addition to reserves; while provisioning is likely to remain elevated, this is likely the peak for provisioning, with charge-offs likely to peak next year.
- The near-term outlook for banks remains challenging, with little prospect for higher rates, but Citi looks undervalued all the same.
I’ve liked Citigroup (C) as a more contrarian call in the larger bank group, and that has worked out alright since the last quarter, with the shares outperforming the bank’s larger peers like Bank of America (BAC), JPMorgan (JPM), PNC (PNC), U.S. Bancorp (USB), and Wells Fargo (WFC). To be clear, this was less a “this is a great bank” call and more of a “it’s not nearly this bad” call, and it seems as though the Street has eased up on some of the pessimism around Citi’s outlook over the past few months.
I expect Citi’s performance to be below-trend through 2022, but I believe Citi has seen the peak in provisions, with actual charge-offs likely to peak in the first half of 2021. Low rates will remain a headwind for some time, and I think Citi’s non-U.S. exposure could be a relative liability over the next couple of years. Even so, if Citi can muster any growth in long-term core earnings (relative to 2019), these shares are significantly undervalued.
A Better Than Expected Quarter, But Core Banking Is Weak
Citi’s performance relative to expectations wasn’t as strong as JPMorgan’s, but Citi likewise had a better than expected quarter as strength in trading and investment banking offset weakness in the core banking operations. At the pre-provision line, Citi beat by about 9% ($0.27/share), with the beat driven almost totally by the Institutional Clients Group (or ICG), with Global Consumer Banking missing by about $0.03. This was “directionally similar” to JPMorgan’s performance, where strong trading offset weaker banking.
Revenue rose 5% year over year and declined 5% quarter over quarter, coming in a little better than expected. Net interest income, which declined 7% yoy and 4% qoq, missed modestly, while fee income (up 28% yoy and down 6% qoq) more than compensated. Net interest income was pressured by weak rates (loan yields down 70bp qoq) and excess liquidity (average earning assets up 10% qoq), with net interest margin declining 31bp qoq (similar to JPMorgan’s 38bp decline) and missing by close to 20bp.
Fee income was buoyed by strong trading and investment banking within ICG. Trading revenue rose 69% yoy, with fixed income up 88%, while investment banking rose 37%. Offsetting that was a weaker result in treasury and trade (down 11%).
Expense control was good, with opex down 1% yoy and 2% qoq on a core basis and the efficiency ratio about two points better than expected. With stronger fee income and controlled expenses, pre-provision profits rose about 12% yoy and fell about 9% qoq. Within the consumer banking business (or GCB), PPOP was down 9% yoy and about 13% qoq.
As I said, core banking activity was generally weaker. Retail banking revenue declined 11% and card revenue declined 9%, with branded card spending volume down 23% year over year. Within the GCB unit, North America outperformed (down 5%) relative to LatAm (down 7%) and Asia (down 15%), and management called out a significantly weaker macro outlook in Mexico.
Overall loans declined less than 1% yoy on an end-of-period basis, while rising more than 3% on an average balance basis as the bank benefited from a starting point elevated by first quarter corporate drawdowns. Consumer lending declined about 3% qoq, with cards down 6% and retail up 3%, while corporate lending declined almost 7%. Corporate lending was down about 10% qoq in North America, significantly worse than JPMorgan’s performance and the average for large banks, but still better than Wells Fargo’s performance. Relative to sell-side expectations, lending activity was inline.
